Monday, 30 March 2015

The
impact of the conflict in Yemen on the oil market is likely to be limited,
unless it spreads outside its borders.

Oil prices jumped by
almost 5% when the Saudis launched
air strikes against Yemen on 26 March. The strikes have raised questions on
whether this could cause a significant supply disruption in the oil market. The
answer depends on how the conflict unfolds and how widespread it becomes. For
this, it is useful to consider three scenarios.

Scenario 1: The
conflict stays within the Yemeni borders. This is the most likely scenario. The regional
foes have tended to fight their wars through domestic proxies, as in the case
of Syria. The scenario promises Yemen years of chaos and misery, but is likely
to have little impact on oil prices. With a production of just 150 thousand
barrels a day (b/d), Yemen is a small producer accounting for less than 0.2% of
global oil supply. Any losses from the Yemeni oil production can be easily
replaced with the Saudi excess capacity. And in any case, the oil market is
ridiculously over-supplied, so a small loss will hardly be noticed.

Scenario 2: The
conflict spills over in a limited way. This could take the form of the
closure of the Bab el-Mandeb Strait. The strait is an important trade route, where 3.8m
b/d of crude oil and refined products passed through in 2013, mostly going
from the Gulf to the Mediterranean. But the closure of the Bab el-Mandeb Strait
does not take this supply out of the market; it just means that the oil tankers
have to use an alternative route around Africa. This would add time and transit
cost, but the impact on the oil market should still be contained.

In this regard, the
strait of Bab el-Mandeb is far less important than that of Hormuz both in terms
of oil flow (17m b/d in Hormuz versus 3.8m b/d in Bab el-Mandeb) but also in
terms of the availability of alternative routes to bypass each strait (there is
not enough pipeline capacity to bypass the strait of Hormuz, while alternative
routes exist to bypass Bab el-Mandeb).

The closure of the Bab el-Mandeb Strait is unlikely. There is a heavy presence of international warships in nearby waters as well as an American military base in Djibouti. And if necessary, the Egyptian, Saudi or even the Israeli navy could be deployed to keep the strait open.

Source: Energy Information Administration

Scenario 3: A
widespread regional war. This scenario is extremely unlikely. But if it did
materialise, it would represent a major shock to the oil market. At risk would
be a third of the world’s oil production. However, it is difficult to imagine
how an outright war can come about. After all, the regional powers have shown a
preference to fight their wars through local proxies and possibly by exporting
fighters rather than engage in a direct conflict.

Conclusion. The impact of the
conflict in Yemen on the oil market is likely to be limited, unless it spreads
outside its borders. The prospect of a regional spillover currently looks unlikely.
Perhaps realising this, oil prices declined sharply on the second day of the
Saudi strikes, reversing all the gains made on the previous day.

Monday, 9 March 2015

Lower
oil prices and confusing policies are starting to cause a dollar crunch in Iraq.

1. Iraq gets almost
all of its US dollars from the government’s sale of oil. To meet the private
sector’s demand for dollars (to pay for imports, travel and medical expenses
etc), the Central Bank of Iraq (CBI) holds daily auctions in which it sells
dollars to the private sector at the official exchange rate (1,166 Iraqi dinar
per 1 US dollar) as long as import receipts are provided.

2. The 2015
budget imposed a new restriction preventing the CBI from selling more than
$75m a day in its currency auctions. The imposed limit reduces the volume of
dollars available to the private sector by two thirds (daily volumes averaged $204m
in 2014). The limit was not in the initial
draft of the budget, but was later added by the parliament to prevent the
depletion of international reserves as oil prices declined, reducing the availability
of dollars in the economy.

3. The restriction on
the currency auction brings back memories of the dollar
crunch of 2013. Following the sacking of its governor, Sinan al-Shabibi,
the CBI significantly reduced the volumes of dollars on offer at the auction. As
a result, the market price of the dollar deviated from the official price. At
its peak, the dollar was sold at 1,292 dinar in the market, almost 11% above
the official price. But even during this episode, the volumes sold at the
auction were about double the new $75m limit.

4. Following the approval
of the budget, the CBI reduced the volume of the dollars sold in its daily auction
to an average of $80m—above the ceiling imposed by the budget, but much lower
than the $204m it sold daily in 2014. Unsurprisingly, the market price of the
dollar began to deviate from the official price. It reached 1,237 dinar to the
dollar on 19 February, 6.1% above the official price.

6. Why is the
currency auction so controversial? Its controversy led to the sacking of a
former CBI governor, the imposition of a limit on the auction’s daily sales and,
ultimately, its outright suspension. Opponents claim that the CBI was lenient
in selling dollars against fake import receipts. The dollars sold were then
used for speculation and sometimes smuggled out of the country.

Are these claims
right? Probably yes. My estimate of private sector imports of goods of services
in 2013 is $41bn, which is below the $54bn sold in the CBI’s auctions in the
same year. This suggests that some of the dollar purchases were indeed used for
speculation and probably smuggled out of Iraq.

7. But is
tightening the supply of dollars the correct response to this? Probably not. As
in 2013, supply restrictions will only lead to a decoupling of the market price
from the official price—a process that is ongoing now despite the CBI’s
insistence that it is only temporary.

Monday, 2 March 2015

Egypt’s
new strategy of less government spending, more investment and higher growth is
a little ambitious

The economy of
Egypt has slowed down considerably since the 2011 revolution. Annual real GDP
growth, the standard measure of economic activity, has averaged 2.1% in 2011-14
compared to 5.6% between 2004 and 2010.

Almost half of that
growth differential was due to a slowdown in investment. It is hardly surprising
that investors have been spooked by the political and legal uncertainty which
have followed the revolution. In the chart below, the contribution of
investment to real GDP growth over 2011-14 is reduced to a barely visible grey
strip below zero. The other half of the growth differential was equally split
between private consumption and net exports as the overall environment proved
detrimental to consumer sentiment and competitiveness.

Faced with this,
the government’s strategy was to increase public spending to shore up the
economy. As a result, the government’s contribution to annual real GDP growth
has increased a little in 2011-14 relative to 2004-10 unlike all the other
components.

But this strategy
is now reaching its limits. The government’s budget deficit in the fiscal year
2013/14 was 13.8% of GDP. Excluding grants from the Gulf, the deficit was a
massive 17.6% of GDP. This is very large and not sustainable for two reasons. First,
because domestic banks—which have lent out large sums to the government in
recent years—will eventually run out of liquidity. And second, because Egypt’s
Gulf backers are showing reluctance to continue writing blank cheques and are seeking a change in the direction
of economic policy.

The Egyptian
government is therefore moving to a new strategy, which is based on replacing
government spending with investment. In its latest
survey of the Egyptian economy (which is published for the first time after
a five-year pause), the International Monetary Fund (IMF) predicts annual real
GDP growth will average 4.5% over 2015-19 despite a significant tightening in government
spending. This is because the IMF expects investments to grow at annual rate of
6.1% over the same period, which is high but still lags the 2004-10 rate.

To achieve this,
the government has been designing and promoting large infrastructure projects. These
include the Suez Canal Regional Development project as well as preliminary plans
to build a large number of housing facilities and construct roads. The authorities
also aim to attract foreign investment and the forthcoming
economic conference on 13-15 March is one platform to advertise the new
strategy.

The new strategy is
sound in theory but has its risks. After all, the factors which have inhibited
investment post-2011 are still largely in place. Egypt needs to attract enough
investments not only to counteract the substantial cut in government spending,
but also to raise growth from its current levels. This might be a little
ambitious given its prevailing circumstances.

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About Me (Ziad Daoud)

I am an economist currently based in the Middle East. I have previously worked for an asset management firm and, before that, I did a PhD at the London School of Economics. The views in this blog are solely my own.